The Bull-and-Bear Case for 2023

Market watchers look for optimism amid the gloom

Tech stocks, Treasury bills, cryptocurrencies, real estate. The great market sell-off of 2022 has been indiscriminate, wiping trillions off the stock market capitalization of risky and not-so-risky assets, and taking a huge bite out of average investors’ retirement plans.

Despite the carnage, many investors are sticking with their beaten-down stock portfolios as they head into the new year. “There doesn’t seem to be a lot of people, despite the drawdowns, who are saying, ‘Hey, the pain has been awful,’” Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, told DealBook. “And the reason is, because all things considered, they’re still up 50 percent since the start of the pandemic.”

Ms. Shalett doesn’t see much evidence that the broader stock market is due for a rebound any time soon, but she’s not writing off 2023 either.

Morgan Stanley has a 2023 price target of 3,900 for the S&P 500 and expects the benchmark index to flatline over the next 12 months. (The S&P closed at 3,844 on Dec. 23, down roughly 20 percent this year.)

Still, Wall Street as a whole hasn’t been so divided about the prospects for the next year since the global financial crisis, reflecting deep uncertainty over U.S. monetary policy, corporate profits and a wider debate about whether the world’s biggest economy will fall into recession. The average forecast expects the S&P 500 to end 2023 at 4,009, according to Bloomberg, the most bearish outlook since 1999. But the predictions range from a low of 3,400 to as high as 4,500, representing “the widest dispersion since 2009,” Ms. Shalett pointed out.

“There’s always uncertainty in forecasts. But you know, many times you have a good gauge of where you are with [Fed] policy, where you are in the profit cycle, where you are in terms of valuation,” she said. “As we head into 2023, it’s been our opinion that all of those things are in flux.”

The bull case

At the upper end of forecasts is Bankim Chadha, chief U.S. equity and global strategist at Deutsche Bank, who sees the S&P 500 closing out 2023 17 percent higher than last Friday’s market close.

It will be a choppy ride to hit that 4,500 price target, however. Mr. Chadha predicts the market will rally through the first quarter (led by a rebound in tech and financial stocks), followed by a big midyear drop, only for stocks to bounce back and return to their 2023 highs by the end of December.

It’s not a completely boldfaced call. Deutsche Bank sees a mild recession arriving by the third quarter of next year. The downturn will affect most consumers, home-sellers and, ultimately, corporate profits — but it will only last a few quarters before some semblance of growth returns.

All eyes on the Fed

What could lift markets next year is a shift by the Fed. If the U.S. central bank starts to tap the brakes on rate increases in 2023, stocks could rally. (Many bulls on Wall Street believe the Fed will cut rates in the latter half of the year as inflation eases, despite zero indication from Fed chair Jay Powell that itwill do any such thing.)

Rob Dent and Aichi Amemiya, economists at Nomura, see another factor influencing Fed policy in 2023: politics. The Biden Administration has been largely quiet throughout 2022 as the central bank raised the prime lending rate to a target range of 4.25 to 4.5 percent from essentially zero a year ago. That silence could come to an abrupt end, particularly if aggressive monetary policy forces employers to cut jobs.

“The criticism from Congress will likely intensify next year as job losses start,” the economists wrote in a recent investor note. “Powell’s hawkish commentary so far has been easier to maintain in an environment with historically low unemployment rates, but that will likely become more difficult once the labor market deteriorates. His semiannual testimony before Congress in February will likely be contentious.”

Conflicting signals for the year ahead

For those who believe in holiday miracles, the last trading week of the year has historically been a winner for stocks. “The Santa rally,” as Wall Street veterans call it, covers the seven trading days that follow Christmas when the S&P 500 typically outperforms its historical rolling seven-day average. The most bullish see the Santa rally as an indicator of future returns well into the new year.

The glass-half-full scenario: There are a few whales still buying stocks. Corporations executed a record $1 trillion worth of share buybacks this year, according to Goldman Sachs.

The glass-half-empty view: Corporations won’t keep up that pace next year, Goldman added.

Ms. Shalett of Morgan Stanley also predicts a dud of a year for stocks. But unlike many of her peers, she sees the U.S. avoiding recession, as resilient consumers continue spending and companies reinvest to keep the economy growing just enough to avoid a slowdown. “The implication of that is inflation is higher for longer, and the Fed is higher for longer,” she added, which explains why stocks will be under pressure as corporate profits slump by 10 to 15 percent.

But there are cases for optimism. Ms. Shalett is advising clients to consider Treasury bills and value stocks that carry high dividends. She also expects emerging market economies, such as India and Brazil, to outperform, helped by a weaker dollar and a gradual easing of energy and food prices in 2023.

Grading Wall Street’s ability to see into the future

How did Wall Street’s predictions turn out in 2022? Mixed. At the start of the year, analysts on average saw the S&P 500 climbing to 4,950. They missed badly.

The problem: Almost nobody saw inflation rising to a 40-year-high, and that the Fed, in turn, would respond with a succession of jumbo interest rate increases to raise borrowing costs to their highest level since 2007.

Wall Street did a better job predicting corporate earnings. Analysts saw earnings per share for the S&P 500 as a whole coming in at $221 at year-end, and it looks like they’ll be within 1 to 2 percent of that call.

But even that doesn’t tell the full story. Corporations were forced to raise prices this year, and that may be why so many of them achieved their profit target, or came so close to doing so, Tom Porcelli, chief U.S. economist at RBC Capital Markets, pointed out in a recent investor note. On a real return basis, which takes inflation into account, corporate profits looked less impressive.

“We just don’t see a real catalyst for growth to bounce back,” he added.

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Bernhard Warner